Security Deposit/Advance is not an Operational Debt under the IBC in Real Estate Cases

Nowadays filings before the National Company Law Tribunal (‘NCLT’) under the provisions of the Insolvency and Bankruptcy Code, 2016 (‘IBC’) for matters relating to insolvency have increased tremendously. Since IBC is a new piece of legislation, it, like any other new legislation, is developing each day either by clarificatory amendments by the legislature or setting of new judicial precedents by the courts, explaining the scope and application of IBC.

In view of the same, the present article discusses a highly relevant and debated topic viz. whether monies paid as security deposit be claimed as owed operational debt by the corporate debtor to the creditor and whether such creditor qualifies as an operational creditor under the IBC.

However, before proceeding on with an analysis of the provisions of IBC and judicial precedents in relation to the same, one must understand what exactly is a security deposit and the nature of the transactions where such deposits are made. A security deposit is paid to comfort/secure the party having the obligation to perform first in a contract. An example of a real estates transaction such as a letter of intent for entering into a lease agreement, wherein the prospective lessee has made the security deposit to the prospective lessor to ensure execution of the lease agreement or a lease agreement as such, is helpful to understand the concept of security deposit. Thus, this article will examine whether such a security deposit paid by the service recipient (prospective lessee/lessee) to the service provider (prospective lessor/lessor) is an operational debt under the IBC.

Under IBC for any amount to be claimed as due by a person representing as ‘Operational Creditor’, such person should demonstrate that; first, such amount falls within the definition of ‘claim’ as defined under Section 3 (6) of IBC; secondly, such a claim should be capable of being treated as a ‘debt’ as defined under Section 3(11) of IBC; and thirdly, the ‘debt’ should fall within the confines of Section 5(21) of IBC i.e. it should be capable of being treated as an ‘Operational Debt’ and such ‘Operational Debt’ must be owed by the ‘Corporate Debtor’ to a creditor who can be considered as an ‘Operational Creditor’ as defined under Section 5(20) of IBC.

Pertinently, a transaction of immovable property cannot be considered as a transaction falling under the term ‘operation’ and ‘Operational Debt’ unless such a transaction has a correlation of direct input to the output produced or supplied by the Corporate Debtor. The same has been affirmed by NCLT, New Delhi in the case of Jindal Steel and Power Limited v. DCM International Limited, No. IB-200/ND/20178. In the said case, NCLT examined the exact same question such as the present, that ‘whether non-refund of security deposit amount given by the operational creditor to the corporate debtor in respect of offices leased in a building is an operational debt, and whether an application under Section 9 of the IBC is maintainable for recovering the same’. NCLT while dismissing the said application, held as follows:

“In other words, the Corporate Debtor is the ‘lessor’ of the property which had been leased out to the Operational Creditor which happened to be the ‘lessee’. Even taking into consideration the report of the Bankruptcy Law Reforms Committee dated 4.11.2015 at face value, it is the Corporate Debtor who can be considered as the ‘lessor’, and if at all providing services to the Operational Creditor by leasing out the immovable property which basically belongs to the Corporate Debtor and not vice versa…

Thus any amount claimed as due by a person representing as ‘Operational Creditor’ should demonstrate firstly that the said amount in default falls within the definition of ‘claim’ as defined in Section 3(6). Such a claim secondly should be capable of being treated as a ‘debt’ as defined under Section 3(11) of IBC, 2016 and finally, the ‘debt’ should fall within the confines of Section 5(21) of IBC, 2016 (i.e.) it should be capable of being treated as an ‘Operational Debt’ and such an operational debt must be owed by the Corporate Debtor to a creditor who can then be considered as an Operational Creditor as defined under Section 5(20) of IBC, 2016.”

In the above case an appeal was preferred before the Hon’ble National Company Law Appellate Tribunal (‘NCLAT’). NCLAT dismissed the said appeal Jindal Steel and Power Limited v. DCM International Limited, Company Appeal (AT) (Insolvency) No. 288 of 2017, filed by the applicant/appellant and held as follows:

“Admittedly, the Appellant is a tenant of Respondent-‘Corporate Debtor’. Even if it is accepted that a Memorandum of Understanding has been entered between the parties in regard to the premises in question, the Appellant being a tenant, having not made any claim in respect of the provisions of the goods or services and the debt in respect of the provisions of the goods or services and the debt in respect of the repayment of dues does not arise under any law for the time being in force payable to the Central Government or State Government, we hold that the Appellant tenant do not come within the meaning of ‘Operational Creditor’ as defined under sub-section (20) read with sub-section 21 of Section 5 of the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to ‘I&B Code’) for triggering Insolvency and Bankruptcy Process under Section 9 of the ‘I&B Code’.”

The said position that refundable security deposit, given in relation to a real estate transaction, does not fall under the ambit of the IBC is also affirmed by NCLT, Chandigarh in Mr. Satish Mittal v. Ozone Builders & Developers Pvt. Ltd. No. (IB)-66(PB)/2017 and NCLAT upheld this NCLT’s order in appeal. NCLAT in Mr. Satish Mittal v. Ozone Builders & Developers Pvt. Ltd. Company Appeal (AT) (Insol.) No. 75 of 2017, while dismissing the said appeal and in context of a refundable security deposit, given in relation to a real estate transaction held as under:

“6. Admittedly, the appellant has not made any claim in respect of goods. The appellant has also not rendered any services for which he is entitled to claim any amount. It is not the case of the appellant that he was in employment or a debt in respect of repayment of dues arising under any law is due to him. As the dues to which the appellant claim does not arise under any law for the time being in force and merely based on the receipt, we find no ground to interfere with the impugned order of rejection of application under section 9 in absence of any merit.”

The above position has also been affirmed by the NCLT, New Delhi in Mrs. Pramod Yadav and Anr. v. Divine Infracon Pvt. Ltd., No. IB-209/ND/2017. NCLT while examining in detail the position under the IBC regarding security deposit in relation to an immovable property transaction, held as under:

“11. To sum up thus only if the claim by way of debt falls within one of the three categories as listed above can such a claim be categorized as an operation debt. In case if the amount claimed does not fall under any of the categories mentioned as above, the claim cannot be categorized as an operational debt, and even though there might be a liability or obligation due from one person, namely Corporate Debtor to another, namely Creditor other than the Government or local authority, such a creditor cannot categorize itself as an “operational creditor” as defined under Section 5(21) of IBC, 2016 unless it is established that such goods or services have direct relationship to input-output operations of the Corporate Debtor and hence disentitles such a person from maintaining an application for CIRP against the corporate debtor as an Operational Creditor. There seems to be some rationale in restricting only to Operational Creditors for initiating a CIRP against a Corporate Debtor other than a Financial Creditor. Default committed to operational creditors in relation to payment of their debt definitely connotes that the Corporate Debtor is not even in a position to service their dues and run the day to day operations of the Corporate Debtor which is a clear pointer to its commercial insolvency warranting the process of insolvency being initiated and restructuring process being put in place……

Thus, this Tribunal is of the view that lease of immovable property cannot be considered as a supply of goods or rendering of any services and thus cannot fall within the definition of ‘operational debt’.”

Furthermore, the position generally on advance payments made under a contract is also quite clear. The NCLT, Kolkata, in SHRM Biotechnologies Private Limited v. VAB Commercial Private Limited, C.P. (IB) No. 799/KBB of 2018, was adjudicating on the issue whether return of advance monies due to breach of terms in the mandate letter/contract signed and executed by the operational creditor in favour of the corporate debtor comes under the purview of operational debt. NCLT noted that the applicant neither rendered any service to the corporate debtor nor did provide any goods to the corporate debtor. There was also no agreement entered into as such in connection with any service or services by the operational creditor to the corporate debtor. In view of the same, the NCLT held that the applicant was not an operational creditor as the claim did not fall within the definition of operation debt under the IBC. Resultantly, the application was dismissed.

While deciding the above, the NCLT, Kolkata also considered the judgment of NCLT, New Delhi in Sanjive Kanwar v. AMR Infrastructure, C.P. No. 06/2017, wherein the NCLT, New Delhi discussed in detail the definition of operational creditor.

Thus, as discussed above, to claim a ‘debt’ under IBC, the same has to be in course of operation i.e. there has either be a seller-buyer or service provider-service recipient relationship between the operational creditor and the corporate debtor. In such cases of security deposits or advance monies, there is no service which would have been rendered by the operational creditor and in fact, service if any, is given by the corporate debtor to the operational creditor.

To conclude, in view of the above judicial precedents and analysis of various provisions of IBC an application filed under Section 9 of the IBC for recovery of security deposit/advance for a debt arising out of non-refund of security deposit/advance in relation to a real estate/immovable property transaction is not an operational debt in terms of Section 5 (21) of IBC, as there is an absence of any element of service being provided by the operational creditor.